Bankruptcy: In re Webster Classic Auctions: is the door finally open for a practical application of section 1146(c)?

• Author: Little, Walter C.

On average, 10,000 petitions for reorganization under Ch. 11 of the Bankruptcy Code are filed every year. (1) Of those companies filing petitions, only 25 percent are expected to have their plan for reorganization confirmed by a bankruptcy court. (2) When further analyzing a company's chance of emerging from Ch. 11 to become a thriving concern, the figure of success shrinks to about seven percent. (3) Although the reasons behind the failure to reorganize successfully vary, there is a constant theme: an insufficiency of funds necessary to achieve or carry out a plan for reorganization.

In an effort to clarify prior law and facilitate successful reorganizations, Congress enacted [section] 1146(c) as part of the Bankruptcy Reform Act of 1978 to give debtors tax relief by exempting post-petition transactions from taxes associated with the disposition or refinancing of real property interests. The objective of the exemption is simple: By limiting the financial obligations of transfers occurring under a reorganization plan, a greater portion of proceeds from the transactions are available to debtors, thereby increasing the likelihood that debtors will efficiently discharge their obligations and emerge from reorganization. Potentially, this exemption can be Of substantial importance to debtors with real property interests located in Florida. (4) Compared to other states, Florida has some of the highest tax rates in the nation on transfers of an interest to real property as well as the financing or securitization of real property interests. (5)

Section 1146(c) of the Bankruptcy Code provides that "the issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under [section] 1129 of this title, may not be taxed under any law imposing a stamp tax or similar tax." (6) The section reads simply enough: Once a plan of reorganization has been confirmed by the bankruptcy court, transfers by the debtor are exempt from taxation. The problem, however, is that the relief granted by the strict interpretation of the exemption may be too little, too late. Depending on the size and complexities of the debtor's business, the period between the filing of a Ch. 11 petition and the approval of the reorganization plan can extend for months or even years beyond the statutory timeframe of 120 days. This preconfirmation period is critical to a debtor's ability to rid itself of burdensome liabilities and liquidate its valuable assets into cash so that it may keep its business operational. Imaginative debtors, identifying the potential value of the exemption and recoguizing the impracticality of its strict application, have requested that courts liberally construe the otherwise plain meaning of the term "a plan confirmed" so that post-petition transactions occurring outside the confirmation of a plan of reorganization are nevertheless exempt from taxation.

Early Interpretation of 1146(c)

The seminal case that broadened the interpretation of the term "a plan confirmed" was In re Jacoby-Bender, 758 F. 2d 840 (2d Cir. 1985). In Jacoby-Bender, the disposition of real property occurred subsequent to the reorganization plan confirmed by the bankruptcy court, but was not specifically referenced in the plan. On appeal at the Second Circuit, the City of New York argued that the confirmed plan did not specifically authorize the sale, and thus the sale was not subject to the exemption, "because the plan did not mention any instrument of transfer and did not give the debtor the authority to make the specific sale." (7) Countering the city's argument as to the need for referencing the transaction in the plan, the Second Circuit noted the bankruptcy court's finding that %he plan's consummation depended almost entirely upon the sale of the building." (8) Disagreeing with the city's position, the court stated that the purpose of Congress enacting [section] 1146(c) was to "facilitate reorganizations through giving tax relief, a purpose served equally well when the reorganization plan leaves details to be settled in the future." (9) The court went on to note that [section] 1146(c) derived from [section] 267 of the bankruptcy act which involved transactions that "serve to execute or make effective a plan confirmed under Chapter X." (10) Since [section] 1146(c) "does not require that the reorganization plan include specifics" and the sale at issue was "necessary to the consummation of [the] plan," the court held that the sale was subject to the exemption, not a plan, the consummation of which, depends on the closing of the transaction in dispute. (11)

A Fork in the Road

Not buying into the logic of the Second Circuit's decision in Jacoby-Bender, the Third Circuit Court of Appeals took a more academic approach to the application of [section] 1146(c) to transactions occurring before a Ch. 11 plan...